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‘With all due respect, this doesn’t make sense’ – Suze Orman explains why this $1.6 million 401(k) rollover plan could backfire

In a recent episode of her Women & Money podcast, Suze Orman took a strong stance on a complicated retirement strategy suggested by a listener.

A 56-year-old retiree, Gina, sought Orman’s advice on transferring $1.6 million from her pre-tax 401(k) to a Roth IRA over ten years without tapping her liquid savings to pay taxes. Her company’s benefits advisor had recommended a series of steps that on the surface seemed like a feasible plan to avoid an immediate tax hit. Orman, however, did not mince her words in her response: “That is absolutely insane.”

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Gina’s approach, as advised by her company, involved transferring $100,000 from her pretax 401(k) to a Roth 401(k) and then from her Roth 401(k) to a Roth IRA. To cover taxes on the conversion, she planned to withdraw $40,000 from her 401(k) and have her company withhold 100% of that amount for taxes. If too much was withheld, she expected a refund; if she was short, she expected to owe a manageable amount.

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The rationale behind this strategy may have been to minimize the upfront tax burden, but Orman was quick to point out its fatal flaw: taxes. When you convert money from a pre-tax 401(k) to a Roth account, you move money from a tax-deferred status to a tax-deferred status. “That’s not a rollover,” Orman emphasized, “that’s a conversion… so guess what? My dear Gina, from that moment on you owe taxes.

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A major misconception in Gina’s plan is the belief that she could somehow reduce the tax impact by moving money between different retirement accounts. Orman clarified that this is not possible: “For example, what did you avoid there?” Any conversion from a pre-tax 401(k) to a Roth IRA triggers a taxable event in the year the conversion occurs, and no amount of shuffling between accounts can avoid that reality.

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Additionally, Orman warned that if Gina’s Roth IRA had not been open for at least five years, even funds from a Roth 401(k) could face taxes on the earnings when withdrawn. This added complication makes Gina’s plan unnecessary and potentially harmful when it comes to unexpected taxes.

What should Gina do instead?

According to Orman, Gina would have to roll parts of the 401(k) directly into the Roth IRA and pay the taxes from savings. Orman recommended converting smaller amounts each year — like the $100,000 Gina originally suggested — but emphasized the importance of covering tax liability with funds outside of the 401(k).

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“If you don’t want to use your liquid savings to pay taxes, don’t do it at all,” Orman said bluntly. There is no escaping the tax burden when converting a pre-tax account to a Roth. The only variable is how you want to handle the payment.

Investopedia also recommends that when transferring money from a pre-tax account to a Roth account, fund the money with savings instead of their 401(k). If you don’t, you could miss out on compounding for years and end up paying more than the original tax amount on the conversion.

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Gina’s situation is a reminder that even well-intentioned strategies can backfire if you don’t understand the tax laws. For retirees with large pre-tax retirement accounts, the appeal of Roth conversions is undeniable: tax-free growth and withdrawals in retirement. However, trying to outsmart the tax system can lead to costly mistakes.

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Understanding the basics of how retirement accounts are taxed is an important step before taking any big steps. Consider talking to a financial advisor you trust who can explain the pros and cons of moving money between accounts.

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This article, ‘With All Respect, This Makes No Sense’ – Suze Orman Explains Why This $1.6 Million 401(k) Rollover Plan Could Backfire originally appeared on Benzinga.com

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